Abstract
I study the relationship between political institutions and sovereign borrowing when constitutional constraints are systematically chosen to obtain better credit conditions. I argue that the impact of institutional constraints on country risk premia depends on the government’s concern with the country’s creditworthiness and its “willingness to repay”; two variables that are hardly observable. To properly evaluate the relationship between political institutions and sovereign borrowing, I focus on the link between institutional constraints and the risk premia of Argentine bonds between 1822 and 1913. Specifically, I analyze whether a “structural break” in the government’s cost of borrowing time-series exists. I use the Perron-Volesang test for structural change with unknown break dates. The statistical analysis indicates that the adoption of institutional constraints led to significant improvements in borrowing terms: the series has a single structural change; and the distinctive break point is associated with the country’s adoption of constitutional checks and balances. Time-series regressions and instrumental variables (IV) estimation reinforce these findings.
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Notes
For a survey of this literature see Eaton and Fernandez (1995).
An important implication is that a change in investors’ perceptions would translate into higher interest rates only when institutions are sticky. Therefore, the empirical findings in Mauro et al. (2006) suggesting that investor-friendly institutions do not lead to an immediate decline in the cost of capital can be accounted for by my argument.
This implication resonates well with the findings in Flandreau and Flores (2009). They show that outright reactionary powers, whose bonds were underwritten by the Rothschilds, were successful borrowers. However, once a country’s credit risk is taken into account, institutional constraints should be associated with better borrowing conditions.
This conclusion is reminiscent of the argument in Stasavage (2003). He posits that interest rates in England fell only after bondholders took control of the Parliament. Note that in light of the argument presented here, his view can be interpreted as the special case in which the ruler cares significantly about borrowing costs.
Even when the domestic money market showed increasing resistance to new issues of bonds, the government never turn to foreign lenders. The default on a loan obtained from Baring Brothers in 1824 forestalled prospects of renewed British and other foreign capital investment. In addition, foreign credit was also difficult to obtain for Rosas because his recurrent episodes of fiscal irresponsibility were not ignored abroad.
The data sources and sample’s construction methods are documented in Saiegh (2011).
All the results are available from the author upon request.
The disturbance terms for each period are allowed to be correlated.
During the 1870s, the country suffered numerous insurrections, provincial rebellions, revolts, and a military confrontation between the governor of Buenos Aires and the national government. In 1890, an uprising against the national government initiated a period of uncertainty in Argentine politics: numerous revolts were plotted in the following decade, including two revolutionary outbreaks in 1893.
The variable 1876 Crisis takes the value of 1 for the period between 1876 and 1879, and 0 otherwise.
The variable Inflation measures the annual percentage change in Argentina’s consumer price index. Source: Ferreres (2005)
The variable Credit Abundance takes the value of 1 for 1888–1890, and 0 otherwise.
Unlike the Argentine federal government, the provincial and municipal authorities did not reach agreements of this kind with their creditors. As such, holders of provincial bonds did lose accrued interest and, in most instances, suffered reductions in principal. The fact that lower levels of government defaulted on their debts, however, does not invalidate the argument that the introduction of limited government reduced credit risk in Argentina.
The variable Baring Crisis takes the value of 1 for the period between 1890 and 1897, and 0 otherwise.
These data were graciously provided to me by Kris Mitchener and Mark Weidenmier.
In light of these results, I re-estimated the structural break test using yields of bond issues that were directly affected by the Barings crisis: (a) the 6 % Funding Loan (swapped debt); and (b) the 5 % 1884 Loan (debt in default). In both cases, there is a single structural break in the series, and it coincides with the adoption of the constitutional constraints.
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Saiegh, S.M. Political institutions and sovereign borrowing: evidence from nineteenth-century Argentina. Public Choice 156, 61–75 (2013). https://doi.org/10.1007/s11127-012-0003-4
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DOI: https://doi.org/10.1007/s11127-012-0003-4